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Edited Transcript of KRU.WA earnings conference call or presentation 6-Mar-20 2:00pm GMT

Full Year 2019 Kruk SA Earnings Call

Wrocaw Mar 28, 2020 (Thomson StreetEvents) -- Edited Transcript of Kruk SA earnings conference call or presentation Friday, March 6, 2020 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michal Zasepa

KRUK Spólka Akcyjna - CFO & Member of the Management Board

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Conference Call Participants

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* Marta Jezewska-Wasilewska

WOOD & Company Financial Services, a.s. - Co-Head of Research

* Michal Kuzawinski

JP Morgan Chase & Co, Research Division - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the presentation of the KRUK full year results 2019. (Operator Instructions)

May I now hand you over to Marta, who will lead you through this conference. Please go ahead.

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Marta Jezewska-Wasilewska, WOOD & Company Financial Services, a.s. - Co-Head of Research [2]

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Good afternoon. My name is Marta Jezewska-Wasilewska, and I represent WOOD & Company that has a pleasure to host today's event of KRUK's annual results discussion.

Therefore, with no further delay, let me hand over to Michal Zasepa, CFO of KRUK. Sir?

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Michal Zasepa, KRUK Spólka Akcyjna - CFO & Member of the Management Board [3]

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Thank you, Marta. This is Michal Zasepa. It is my pleasure to present the 2019 net results. I'll be using the presentation that was made available on our website earlier today.

2019 has been a difficult year for KRUK Group. For the first time in our history, our net profit decreased compared to the previous year. We still earned significant PLN 277 million, which is 22% of the profitability of net income and 14% on return on equity. This year was relatively weak, weaker-than-expected on net profit due to several unforeseen circumstances of events that I will discuss later, but it has been a good year. If you look at recoveries of the business, especially, in Romania, they were very good in Poland. They were also good and improving in Italy.

It was a good year also on cash EBITDA. We had 12% growth of that measured, and we remained highly profitable, well funded, low leverage. Business prepared to continue profitably in 2020 and beyond.

I will now go to discuss certain geographies and our main geographies and the results of those segments. I'll start with Poland, and I'm looking at Slide #9. Poland was, again, our main market for investments in 2019. The market itself, as you may see on Slide #9, was PLN 13 billion in nominal or PLN 1.4 billion in terms of invested capital. That was below our expectations. Although, it was a decent size of the market, a significant part of that market in 2019 was 1 transaction of GetBack's assets for about PLN 400 million or EUR 4 billion. No, we have not won that transaction, but we have won a number of other primary market transactions, which allowed us to have over 20% market share for that year.

Q4 was the best quarter in terms of supply of the portfolios. We saw several Polish banks starting to sell, so that bodes well for 2020, and we see already some portfolios. Although, we're not in a position today to firmly tell you that the market in 2020 will be much larger than the 1 we saw in 2019. We definitely see a lot of portfolios, but we cannot yet clearly state how big the market will be in 2020.

If you look at Slide #10, Polish business results, we invested PLN 340 million. That's less than we anticipated. It's still, as I said, over 20% market share. We would like to invest more this year. We have a place still to be a little more aggressive on expected returns. As you see in this presentation, our overall return from that purchase in 2019 was high. It was 24% gross IRR, up 2 percentage points from 2018.

Coming back to Poland, PLN 820 million of recoveries, 7% increase, a very good result. Although over 2019, there was a period of a couple of months, where the results were on the accounting curve not as usually above that. And as a result, you've seen less of positive revaluations. There were none in Q3, and there were little small positive ones in Q4.

Looking ahead in 2020, when I see the positive recovery strengths, I would expect that some positive revaluations will come up, although they are in rather decreasing trend as this bad boo portfolio in Poland is maturing.

And credit management services show a small decline. We made some organizational changes there, repositioned ourselves, and we hope to see better margins there in the future. So overall, the Polish business performed very well. 28% profitability, looking at the value of the -- book value of portfolios and operating profits, good recoveries, decent investments. We hope for more next year.

Romania, a relatively stable market despite, as you may have heard, some changes in the legislation that has happened or some proposal that never got passed. We continue to do business as usual. We saw over PLN 300 million worth of portfolios traded, PLN 2.8 billion nominal. And as you can see on Slide 12, the great majority of these portfolios we successfully bought on the market, commending a dominating market share of over 70%, and invested into 50 portfolios PLN 254 million.

Recoveries were great. They were significantly above the accounting curve, which allowed us to once again recognize significant positive revaluations of PLN 100 million for the entire year. Also, the credit management business, the service business performed very well above the plan. We saw growth of revenues of close to 40% and also a significant growth of operating profit.

Looking at 2020, we expect a relatively stable supply of portfolios seen, and we count on having a very significant part of share of that market again.

Italy, the market is shown on Slide 13, we were active in that the market mostly in the last quarter of 2019, where we invested most of this or close to PLN 100 million investments that you see on Slide 14.

Recoveries were -- are in positive trend for the Q4 and also for the first months of 2020. We are making our operating targets. That, plus the fact that we have sent to the legal process substantially more cases than initially anticipated, which is positive because it builds our potential future recoveries, allowed us to recognize for the first time, a significant positive revaluation of PLN 13 million. So the entire year, the full year, we end with negative revaluation of minus 14 net.

So I would say the debt purchase business is an improving trend. It's not yet a situation where we would say we have full comfort about the valuation of our portfolios. The legal process is still ongoing. We still are relatively young in that process. So the risk persists. It's decreasing as we -- as times goes by, but it's still there. But the past 5 months in Italy were the best 5 months we've had in that business.

Credit management services, on the other hand, had a very difficult year in 2019. You may recall over 2 years ago, KRUK has purchased a small servicing company, Agecredit, run so far -- run until the time by the owner, was replaced by KRUK manager, an Italian national, who worked with us for about 2 years. Unfortunately, this new manager did not manage that company well. There was several mistakes that were made, contracts that were signed, people that were employed or let go, that were clearly not good decisions for the company. As a result, the business went into losses. And we have decided sometime in Q3 last year to dismiss this person, started restructuring process and successfully recruited a replacement for the manager for the business early in January this year.

However, since the results of that business were very bad, it was several million zloties of operating loss. And this year, although the improvement has been made, and we are realizing, the plan still calls for negative operating profit for the 2020, we and the auditor decided, it's prudent to take a loss and write down the goodwill for that company in the amount of PLN 13 million. So it's a noncash loss that we have booked into the revenues of the credit management service. And you see on Slide 14, it's minus PLN 1 million of revenue, which is the consequence of that.

We believe in the servicing business. We think we learned the lesson, but, unfortunately, we write down the goodwill.

On Slide 15, you see information about the Spanish market, Czech and Slovakian market. I won't comment on that much.

I will go further to Slide 16. The performance of this segment, you see that we invested PLN 19 million. That's a combination. Most of that is Czech and Slovakia portfolios, and there was a few small Spanish portfolio, mostly in SME segment that we have bought. We've been very careful in putting more -- taking more risk in Spain. As we saw that, unfortunately, the performance of the larger consumer finance portfolios or banking portfolios that we have bought before 2019 was disappointing.

The underperformance was significant and it resulted in over PLN 46 million of negative revaluation for the full year. Part of that was booked in Q4. The underperformance, we also saw in the credit management business. You can see here that the revenues fell by 30%. That is a negative as well. We have made management changes there. And also, in the late January of 2020, we replaced the country manager for the entire Spanish operations. And we have placed there an experienced manager from Romania, who successfully has run our credit management service operations there for several years.

2020 is a challenge for us in Spain. We need to stabilize the organization. We need to improve the operations. It's a year where we are likely not to invest much in new portfolios, but to seek operational improvements and management improvements. We are still recruiting for a few positions, replacing the weak chains, weak elements of the chain -- of the management chain, and the plan is to stabilize the situation in the next few months.

There is a risk that we want investors to understand that if we will continue to underperform in Spain. We will be at risk with further negative revaluations of portfolio. And also with writing down a part of the goodwill for the credit management service company that we have bought there several years ago.

The total goodwill value on our books is about PLN 54 million, so it's much bigger than the Italian merger. I'm not saying that is likely. I'm saying the results need to improve according to the budget for the service business for that not to happen that year.

On Slide 17, you have Wonga, a consumer finance business we have bought in May 2020. This business performed according to plan. We're very pleased with the cooperation with the management and with their results up to end of the year. The business grew 90% in terms of its balance sheet, and it started to be profitable from Q3 2019. However, there was 1 unforeseen legal event that we accounted for in our books that, unfortunately, made this business unprofitable for 2019. And this event is the interpretation of the current law by the Polish Antimonopoly and Consumer Protection Office, which based on legislation or some verdict decision of the European Justice Tribunal says that every bank, every consumer finance company in Poland needs to repay, to return provision paid by the client, if that client prepays the loan. And the only method that this provision should be repaid is proportional linear method, which practically means, that if somebody takes a loan and repays this loan after 1-day or 7 days, this loan is for free. It does not account for any risk of the capital. That is -- that the credit company has.

Wonga has been 1 of the few companies on the Polish market, including all of the Polish banks, which was systematically repaying this prepayment, those provisions to the credit, since its inception. So from that point of view, we understood what the law was. We understood the tribunal verdict, and we were happy that our competitors will be now forced to be in line with us.

However, what we did not come see -- did not see have it coming was that the Polish regulator started to announce their decision against our competitors, early published in January and February, where they said were the Polish UOKiK -- the entire consumer protection office said, only repay, but only the linear proportional method is the right method.

Now we and our auditor recognize, we recognize that there's a risk, that this consumer protection office will have the same decision against Wonga. No control is in process. Clients do not ask us to repay. But to be prudent, we made a provision for a potential loss of cash flow if we were to return to clients the difference between the payments we made, to the payments calculated in the method that the consumer protection office calculated.

If you ask our lawyers, they'll tell you, "Well, Wonga did it the right way." But unfortunately, it's not what the Polish regulator says. It remains unclear how the entire industry will react. There is no court verdict on that. There will likely be. This UOKiK's decision, the consumer protection office decisions were taken to court by some of our competitors. We are now analyzing the situation, designing what's the best course of actions, and we bear the consequence of creating this provision, which, unfortunately, meant Wonga reported minus PLN 10 million of EBITDA loss for 2019.

Even in this -- if this unfortunate consumer protection office stance will not change, our plan is to show profits in Wonga this year. Wonga's assets, just to remind you, represent less than 5% of KRUK's Group's assets. So it remains a relatively small part of business.

On Slide 19, we show you historical recovery curve, which shows on everything that KRUK has invested in. Since 2005, we made 3.7x money, pretty, I think, a good return. It also tells you, somewhere in the commentary, that, in 2019, the investments we made that's close to PLN 800 million were made at gross expected return of 24%, 2 percentage points more than in 2018. So again, very good results, and which compensates part or significant part of not making over PLN 1 billion of investments, as we initially planned in the budget.

Looking at the perspective for 2020 and following years, my comment is the following. Looking at where we are, the results of this year, the expectations for new investments, it's clear that we are not in line with the 6 years plan we discussed with -- we presented investors, which called for PLN 700 million of net profit by 2024. We don't have a new target. We usually make 4 years business plans. We will update our strategy and business plan in the subsequent months. But based on 2019 results and our expectations, we can already tell you that our target will be lower than the PLN 700 million. Still, we believe there's growth opportunities. There is -- there will be portfolios to be bought. We will be working to show growth in the subsequent years, but at the pace which will be lower and likely will not lead us to as much as PLN 700 million by 2024.

Looking at 2020, our budget calls for growth. This growth, to give you some point of reference, is somewhere a little bit below our historical record results of 2018.

In terms of investments, we would like to increase the value of investments from this PLN 800 million, but that will depend on -- of course, on supply of how much more we'll be able to invest in Poland this year up from this PLN 340 million last year and what will be our appetite for increasing investments in Italy. It's unlikely, as I said, that we will be investing much in Spain this year, but that hopefully will change toward the end of this year and in the following year.

One more comment. We have finished that year with -- still significant profit with a lower -- relatively lower level of investments with low level of leverage. There is a space and willingness from our side to share these profits with shareholders. The management is now working on the recommendation. The alternative is dividend or buyback. For the past 5 years, we were paying the dividend. We are now contemplating the alternative buyback. If our conclusions will be -- it is an attractive options -- we'll propose terms to shareholders, who will decide what they prefer. And we are likely to make such a recommendation in the next few weeks.

And maybe 1 more comment before I ask for your questions. We all watch news about coronavirus and how it affects the world and business. As you know, we have significant business in Italy and 300 people there. At this point, I can say, we see no impact of that situation on KRUK.

In Italy, our recoveries so far are on plan, and we see no negative trend. Out of our 300 employees, 1 is quarantined in the region, where he cannot travel. But he's working from home -- from home office. So far, so good, I would say. But we have contingency plans ready to have much more people working from home offices and to react to whatever the situation will evolve into it.

Of course, it is a negative -- this situation can have negative effect on us. And we're trying to think how to prepare for that best, but there is nothing concrete that has happened that would be visible right now.

That is my commentary, and I'll ask you now for your questions, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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Michal Kuzawinski, JP Morgan Chase & Co, Research Division - Research Analyst [2]

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It's Michal Kuzawinski from JPMorgan. Michal, I would like to hear from you mainly to assess the situation in Spain. I mean, there was a big revaluation. How do you see this business going forward? And again, what is the plan? How to rectify the situation in Spain?

And if you can also comment on key actions taken to address the poor performance in Agecredit, please.

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Michal Zasepa, KRUK Spólka Akcyjna - CFO & Member of the Management Board [3]

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Okay. So starting from Spain, our diagnosis is we have both the problem of being a young organization and probably making some imperfect valuations with the portfolios we bought. This uncertainty probably, also is part of that problem, but also what we identified is that, we weren't -- from the management point of view, we weren't up to speed. We weren't effective enough in making sure we have already built the most effective operations there.

Now we cannot address the first point if certain time does not pass, and if we don't have the second point managed well, meaning operating effectiveness. And this is where -- actually where we can make changes. And we did them. And we made some management changes earlier in 2019, and we made 1 big management change in late January this year. And today, we're supporting these new managers. We're recruiting new ones. We are in a position where we say, "Forget for some time new portfolios with maybe some small exceptions. Concentrate on diagnosis, what you can improve on operating process and recompleting or making the management team complete." So that we're calm, steady. We know we've made some mistakes, but it's time to work inside the company, make sure we were organizing ourselves as best as we can as we do it in Poland, Romania or now Italy.

So we'll make that work. And I think this year -- but that means less investments. And of course, potentially, there is a risk that there is still some negative revaluation in the future. But that's a potential risk in a situation where we identified that there are some things we can and we have to improve in the organization. We're committed to support this business. We're not definitely thinking of winding down, but we need to make a thorough analysis and changes of the business.

Regarding Agecredit, we are starting to restructure that company sometime in September. We let the manager go, the country manager for Italy, who is running our debt purchase business. Together with some support from the headquarter, we're running the restructuring process. In that process, we canceled some of the loss-making agreements that -- the old management side. We have downsized the organization. We have relocated people to work, that they can do and should be doing. There was, unfortunately, a few basic management mistakes where the resources of the company were not used at its best, as best and some contracts were signed that never should have been signed. That is all cleared. As a result, the company reduced by 30% the cost level and, as a result, also decreased the net -- the operating loss very significantly. And we have successfully recruited an experienced manager, who joined us in the beginning of January. And now we are in the mode of -- based on this reduced cost base, coming back to the clients, we lost a few clients over 2019, and to develop pipeline for the new ones.

So that after -- as we are in the beginning of March, I can tell we are on plan of improving the business and making it profitable again at the end of this year. It's a small business. Unfortunately, that was painful. And it was painful to write down the goodwill, but I think we reacted after a delay in some management mistakes that we made. We reacted as well as we could. And we will success -- eventually succeed with that business and with servicing business in Italy.

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Michal Kuzawinski, JP Morgan Chase & Co, Research Division - Research Analyst [4]

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So maybe I have follow-ups on both. So do you see you can implement some of your Italian experience, which seems to have worked recently, in terms of improving these operations? Do you think whatever you've improved in Italy could also work in Spain? And that on Agecredit, can you tell me how much was the goodwill write-down? And was this essentially -- that was the problem with profitability, that the contracts were not profitable enough or they were not enough, there was not enough business to hide fixed cost base? What was the nature of the profitability problems recently?

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Michal Zasepa, KRUK Spólka Akcyjna - CFO & Member of the Management Board [5]

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The goodwill was PLN 13 million. And that is the value that was written down. The problem with Agecredit being loss-making is the following. We've bought a business which was on a breakeven EBITDA and, unfortunately, the results of some decisions of the manager that we let go was that cost base increase. There was a few people that were recruited that shouldn't have been. There was a few contracts signed at a loss. And a significant part of the organization was asked to work on those new contracts, jeopardizing some of the profitable contracts that we're working on so far. As a result, a few clients left. A few profitable clients left. And on the new business, we incurred loss. So it was a clear mismanagement, which we identified some time in September, and we eliminated that. Can we make -- so when you look at this under the standards now, obviously, that's obvious what went wrong.

Coming back to Spain, well, the manager that we now asked back in 2019 around credit service management business was a manager that helped us develop our servicing business in Romania. It's a Romanian manager. This person now became the country manager for that person. So we feel we've put a much stronger person there in charge. Now if you compare Spain and Italy, I think the difference is, in retrospect, the quality of the managers we have sent to work on the case or recorded locally.

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Michal Kuzawinski, JP Morgan Chase & Co, Research Division - Research Analyst [6]

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Is this the person -- yes. I just wanted to ask, is this the person we met in La Spezia, in 2017?

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Michal Zasepa, KRUK Spólka Akcyjna - CFO & Member of the Management Board [7]

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The person you met in La Spezia is our country -- our head of operations is still Head of in La Spezia.

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Michal Kuzawinski, JP Morgan Chase & Co, Research Division - Research Analyst [8]

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In Romania?

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Michal Zasepa, KRUK Spólka Akcyjna - CFO & Member of the Management Board [9]

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Yes. So he is -- you probably referred to Catalin Cucu, who is our Operational Director and still is in position there. So no change there. The person which we sent was running our servicing operations in Romania, and this position was allocated to Spain now.

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Michal Kuzawinski, JP Morgan Chase & Co, Research Division - Research Analyst [10]

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Okay. Okay, clear. And just the last question for me. Talking about kind of conditionalities and uncertainties in this market environment, in case this is a bigger tsunami than just a storm, like how are you thinking about keeping your powder dry here in terms of investments? And from -- on one hand in making sure that you're comfortable with kind of maturity profiles and refinancing schedules here. On the other hand, just you might see a bigger supply of NPLs here and better pricing 2 months from now. So how are you kind of thinking about this? Is it the time to kind of a little bit press on the brake pedal and see how the situation develops?

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Michal Zasepa, KRUK Spólka Akcyjna - CFO & Member of the Management Board [11]

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We have a comfort coming from 2 things. The first thing is, we are a low leveraged companies with high safe -- liquidity cushion. There is very little of the bonds that we need to repay this year. So we are comfortable in terms of how much money we have on disposal.

Second thing that helps us is that the Q1 is naturally a quarter where we don't invest much. So we have time now before actually make a decision is the situation with coronavirus getting so serious that we actually should behave differently and maybe raise expectations for returns, limit investments until probably March/May this year, when I hope more clarity we will have on that situation. So we have not changed now any of our investment policies, but we are not making big decisions this month or probably even next month on some large investments. We'll watch the situation. We'll see what the front runner, meaning Italy, is doing and how the business is affected there. We -- of course, we don't know what will happen, but I feel we are in relatively better position than most of our competitors because we are the least leveraged company in the market now from the big debt purchasers in Europe.

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Operator [12]

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At the moment, there are no further questions. (Operator Instructions) We haven't received any further questions, so I would like to hand back to you.

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Michal Zasepa, KRUK Spólka Akcyjna - CFO & Member of the Management Board [13]

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Thank you very much for dialing in and listening to our results commentary. We start this year hoping to and planning to grow profits. We have very solid and profitable business in Poland, Romania and 5 months of very good developments in Italy. Spain remains a challenge for 2020, but the challenge we are facing now and we'll work out to see much better position towards the end of the year. We also hope to see a turnaround in Wonga and some profits there this year. Of course, we don't know what will happen in terms of the coronavirus, but, so far, nothing negative has been observed by us. And in that business, in the NPL business, please remember, profits are made in the bad times much easier than in the good times, and I think we are prepared for the bad times much better than most of the more leveraged companies.

Thank you very much. I hope to talk to you or see you sometime over the year, although some of our Investors conferences are being canceled. Now I've learned today that [PTO BP conference] in London, unfortunately, has been canceled due to the coronavirus, but there will be other locations.

So far, we're still planning to go to New York in the second part of March. So for those of you who will be there, I'll be happy to talk to you there. Thank you very much. Have a good day.

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Operator [14]

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Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.